Chapter 17 - Auditors' Reports
CHAPTER 17
Auditors' Reports
Review Questions
17–1
The sections of the standard audit report for a nonpublic company are: (1) introductory section (which
does not have a section title), (2) management’s responsibility for the financial statements, (3)
auditor’s responsibility, and (4) opinion.
17–2
The function of notes to financial statements is to provide adequate disclosure when information in the
financial statements is insufficient to attain this objective.
17–3
The primary differences are that the PCAOB report (3 required):

Includes the words "Registered" in the title.

References standards of the PCAOB rather than generally accepted auditing
standards.

Includes less detailed discussions of management and auditor responsibilities.

Includes an additional paragraph indicating that the auditors have also issued a report
on the client's internal control over financial reporting.

Does not include section titles.
17–4
Disagree. While GAAP is a frequently used financial reporting framework, GAAS is a set of auditing
standards, not a financial reporting framework.
17–5
The types of unmodified and modified opinions include:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Unmodified opinion —standard.
Unmodified opinion with an emphasis-of-matter paragraph.
Unmodified opinion with an other-matter paragraph.
Unmodified opinion with divided responsibility on group financial statements.
Qualified opinion.
Adverse opinion.
Disclaimer of opinion.
17–6
The report should be dated as of the date Green obtained sufficient appropriate audit evidence to
support the opinion, February 20. (The financial statements and the review of the audit both must be
completed.)
17–7
No. Reference to a component auditor in a group audit report, in itself, does not represent a
qualification. Rather, this form of opinion merely divides the auditors' overall responsibility for the
17-1
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
engagement between two or more CPA firms. Note, however, that factors other than the division of
responsibility may lead to a qualified report (i.e., departures from GAAP and scope limitations).
17–8
The wording of a report with an unmodified opinion might depart from the wording of the standard
report when (only three required)

Substantial doubt about an entity’s ability to continue as a going concern exists.

Principles of accounting have not been consistently applied in relation to the prior year.

The auditors wish to emphasize some matter in the financial statements (e.g., significant
related party transactions, significant events, uncertainties).

A group auditor makes reference to a component auditor.
17–9
The audit report should include an emphasis-of-matter section that describes the change and makes
reference to the financial statement note explaining the nature of and justification for the change in the
method of valuing the inventories and the effect of such change upon the financial statements.
17–10 The two circumstances resulting in modified opinions are (a) materially misstated financial statements
(a “departure from GAAP”) and (b) inability to obtain sufficient appropriate audit evidence (a “scope
limitation”).
17–11 The statement is incorrect. If the misstatement is immaterial, an unmodified opinion may be issued. If
it is material, the auditors issue either a qualified opinion or an adverse opinion depending upon
whether they believe the misstatement is pervasive.
17–12 Effects of misstatements become pervasive when, in the auditor’s judgment, they meet one or more of
the following three criteria:

They are not confined to specific elements, accounts, or items of the financial statements;

If confined, they represent or could represent a substantial proportion of the financial
statements; or

In relation to disclosures, they are fundamental to users’ understanding of the financial
statements.
17–13 A client can avoid an opinion qualified because of inadequate disclosure merely by making the
appropriate disclosure in the financial statements.
17–14 In such a circumstance a Basis for Qualified Opinion section is added to the report and the opinion
paragraph is modified.
17–15 Since the auditors have not been able to form an opinion on the financial statements taken as a whole,
they must disclaim an opinion. However, they should set forth their reservations about the accounting
treatment of the deferred income taxes in an explanatory paragraph to their disclaimer.
17–16 Ordinarily, adverse opinions do the client no good. Presumably, creditors and stockholders would not
provide debt or equity capital and, if the client is under SEC jurisdiction, the SEC might launch an
investigation of management for violations of the federal securities acts. Thus, the client usually will
make whatever changes in the financial statements that the auditors require in order to avoid receiving
an adverse opinion. In fact, in the few cases in which the client and its auditors cannot agree, the client
would probably discharge the auditors instead of having them complete an audit that culminates in an
adverse opinion.
17–17 The statement is not correct. A basis for modification paragraph is of three possible types: (1) basis
for qualified opinion paragraph, (2) basis for adverse opinion paragraph, and (3) basis for disclaimer of
opinion paragraph. While GAAS (and international standards) refer to a basis for modification
17-2
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
paragraph, that term is not used in an audit report—one of the three more descriptive terms is used
when an audit opinion is modified.
17–18 Yes. Each year’s financial statements "stand alone." Thus, the CPAs may issue different types of
opinions on the financial statements of successive years when reporting on comparative statements.
17–19 Yes. When reporting on comparative statements, CPAs should update their report on the prior year's
statements to determine whether it is still the proper type of report to accompany those statements. For
example, a departure from GAAP that existed last year, resulting in a report qualification, might have
been corrected. In this case, it is appropriate for the auditors to revise their report on the prior year's
statements to a standard unqualified report.
17–20 The reports containing audited financial statements filed by a company subject to the reporting
requirements of the SEC may include:
Forms S-l through S-11. These are the "registration statements" for clients planning to issue securities
to the public; they are accompanied by comparative audited financial statements.
Forms SB-1 and SB-2. These forms are more simplified registration forms for small businesses.
Form 8-K. A report filed upon the occurrence of a specified significant event. If the event is a
significant acquisition or disposal of assets, Form 8-K will be accompanied with pro forma financial
information. An 8-K report is used to report a change in auditors.
Form 10-Q. This form includes quarterly financial statements reviewed by the company’s auditors.
Form 10-K. This report is filed annually by publicly owned companies and includes audited financial
statements, reports on internal control over financial reporting, and other detailed financial
information.
Questions Requiring Analysis
17–21 a.
(1)
(2)
(3)
b.
(1)
(2)
(3)
The first sentence of the statement is partially true. It is important to read the notes to
financial statements because they provide important supplementary information.
Notes often pertain to complex matters and are presented in technical language.
Certainly it must be acknowledged that sometimes they could be presented in a clearer
form.
To the extent the notes supplement disclosures in the body of the financial statements,
they could reduce the auditors' exposure to third-party liability. The disclosure must be
supplementary, not contradictory.
The second statement is wrong in asserting that the notes can be used to correct or
contradict financial statement presentation. Notes are an integral part of the financial
statements. If there is contradiction or if the presentation is incomprehensible, this
constitutes inadequate reporting and requires qualification of the audit report.
The statement fails to recognize that while there is a need for accuracy and
completeness, those notes should also be comprehensible.
The statement incorrectly assigns management's primary responsibility for the
financial statements and notes to the auditors. The auditors' relationship to the notes is
the same as their relationship to the balance sheet and other financial statements; their
actions are governed by the same reporting responsibilities and liabilities to interested
parties.
17-3
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
(4)
Because notes are prepared by management, the auditors cannot control their content.
Other advisers, e.g., legal counsel, will influence the wording of notes. The auditors
properly should recommend improvements in presentation, but they will modify their
report’s opinion only if disclosure is inadequate or so unclear as to be misleading.
17–22 a.
The group auditors are not required to make reference to the component auditors. Making
reference merely divides the auditors' collective responsibility for the engagement between the
two CPA firms. If the group auditors are willing to assume full responsibility for the
engagement (which they often will do if they retained the component auditors), they need
make no reference to the other auditors in their report. Note, however, as is discussed in the
chapter, when no reference is made the group auditors must perform additional audit
procedures, the scope of which is based upon the significance of the subsidiary audited by the
component auditors.
b.
Although Jones & Abbot issued a qualified report on the Canadian subsidiary, Rowe & Myers
do not necessarily have to qualify their report. Rowe & Myers will evaluate issues in light of
what is material to the consolidated entity, whereas Jones & Abbot evaluated them in relation
to what was material for the Canadian subsidiary. As the consolidated entity is larger than the
subsidiary, the problem at the subsidiary may be immaterial to Dunbar Electronics.
17–23 a.
When a component auditor exists, the group engagement partner should determine
whether sufficient appropriate audit evidence can reasonably be expected to be
obtained regarding the consolidation process and the financial information on the
components. In addition, the group auditor should obtain an understanding of

Whether the component auditor is competent and understands and will comply
with all ethical requirements, particularly independence.

The extent to which the group engagement team will be involved with the
component auditor.

Whether the group engagement team will be able to obtain necessary
information on the consolidation process from the component auditor.

Whether the component auditor operates in a regulatory environment that
actively oversees auditors.
b.
If Michaels decides to make reference to the audit of Thomas, Michaels' report should indicate
clearly, in the auditor’s responsibility section of the audit report the division of responsibility
between that portion of the financial statements covered by Michaels' audit and that covered
by the audit of Thomas. In the opinion paragraph, after “In our opinion,” the following should
be added “based on our audit and the report of the other auditors.”
17–24 a.
Information contrary to an assumption that a client will remain a going concern usually relates
to the company's ability to meet its financial obligations. Conditions that indicate such a
problem include recurring operating losses, working capital deficiencies, adverse financial
ratios, defaults on loans, and arrearages in dividends. Other conditions such as work
stoppages, legal matters, legislation, and loss of principal customers may also indicate a
question as to a client's ability to remain a going concern.
b.
After discovering conditions and events that might indicate substantial doubt as to whether a
firm can continue as a going concern, the auditors must obtain and evaluate management's
plans for dealing with the conditions and events. After reviewing the feasibility of
management's plans, if the auditors still believe that there is substantial doubt as to ability to
17-4
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
continue as a going concern, they should determine that the matters are properly disclosed in
the financial statements and also should modify the audit report to reflect that conclusion.
Objective Questions
17–25 Multiple Choice Questions
a.
(3)
When the auditors take exception to the application of accounting principles in the
client's financial statements, they will issue either a qualified or adverse opinion,
depending on whether the misstatement is considered pervasive.
b.
(2)
The audit report should be dated no earlier than when the auditors have accumulated
sufficient appropriate evidence. This date is often the last day of fieldwork.
c.
(1)
Reference to the work of a component auditor is not, in itself, a qualification of the
group audit report. This reference does not lessen the auditors' collective
responsibility. Rather, it merely divides this responsibility among two or more CPA
firms.
d.
(4)
This phrase violates the fourth standard of reporting, because it does not give the
reader of the report a clear-cut indication of the auditors' opinion. The phrase appears
to modify the standard opinion paragraph, but is not forceful enough to constitute
qualifying language.
e.
(1)
The auditor communicates through the auditors' report, and therefore only answer (1)
is correct. Note that the client will include a discussion of the related party
transactions in a note to the financial statements.
f.
(3)
When a misstatement is pervasive, an adverse opinion is appropriate.
g.
(1)
A consistency modification results in an emphasis-of-matter paragraph. Qualified and
adverse opinions include a basis for modification paragraph. When a report refers to
component auditors no additional paragraph is added.
h.
(2)
An audit report of a public client indicates that the audit was performed in accordance
with standards of the Public Company Accounting Oversight Board (United States).
i.
(3)
An audit report for a public client indicates that the financial statements are presented
in conformity with generally accepted accounting principles (United States). The
PCAOB does not issue accounting standards.
j.
(3)
Substantial doubt about a client’s ability to continue as a going concern results in
either an unqualified report with explanatory language or a disclaimer of opinion.
Accordingly answer (3) is correct since a qualified report is not appropriate.
k.
(2)
When an unjustified change in accounting principles occurs, either a qualified or
adverse opinion is appropriate as this represents a departure from generally accepted
accounting principles. Accordingly, answer (2) is correct since an adverse opinion,
but not a disclaimer of opinion is appropriate.
l.
(3)
An emphasis-of-matter paragraph is appropriate when an auditor wishes to emphasize
a matter concerning the financial statements, but not a matter concerning the scope of
17-5
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
the audit engagement. Accordingly, answer (3) is not a situation in which an
emphasis-of-matter paragraph is appropriate since confirming accounts receivable
relates to the scope of the audit.
17–26 Task-Based Simulation
a.
b.
c.
d.
e.
1. An unmodified (standard report) should be issued.
6. Either a qualified or an adverse opinion is required. Valuation of properties at appraised
values is not in accordance with generally accepted accounting principles. Since the
difference between appraised value and cost is significant, an unqualified opinion would not
be appropriate.
7. A scope restriction results in either a qualified opinion or a disclaimer of opinion. Because
we have no information on whether a possible misstatement could pervasively misstate the
financial statements, either type of opinion is possibly appropriate.
3. Because the misstatements could be material, but could not pervasively misstate the
financial statements, a qualified opinion is appropriate.
6. A qualified or an adverse opinion is necessary. The CPA firm has acquired sufficient
appropriate evidence to the effect that the investments in stock of subsidiary companies are
overstated. Note disclosure does not compensate for improper balance sheet presentation.
17–27 Task-Based Simulation
a.
b.
c.
d.
e.
5. Because the possible effects on the financial statements of undetected misstatements, if
any, could be both material and pervasive, a disclaimer is appropriate.
1. When no reference is made to the component auditors, a standard unmodified report is
issued.
3. A lack of disclosure leads to either a qualified opinion or an adverse opinion. Since the
effect is material, but not pervasive, a qualified opinion is appropriate.
2. Since the auditor concurs that the change is desirable, an unmodified opinion with an
emphasis-of-matter paragraph is appropriate.
4. Because the auditor does not concur with the change, it is a departure from GAAP.
Because the amount is material and pervasive, an adverse opinion is appropriate.
17-6
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
17–28
Item
No.
Emphasis-of-Matter
Paragraph on
Consistency Added?
Type of Change
(1)
An accounting change involving a change
from one generally accepted accounting
principle to another generally accepted
accounting principle.
Yes
(2)
An accounting change involving a change
in an accounting estimate.
No
(3)
An error correction not involving an
accounting principle.
Yes
(4)
An accounting change involving a
correction of an error in principle that is
accounted for as a correction of an error.
Yes
(5)
A change in accounting estimate effected
by a change in accounting principle.
Yes
(6)
Not an accounting change but rather a
change in classification.
No
(7)
An accounting change from one generally
accepted accounting principle to another
generally accepted accounting principle.
Yes
17–29 Task-Based Simulation
1.
(F,J)
A situation in which an auditor is unable to obtain audited financial statements for an
investee represents a scope restriction. Scope restrictions lead to either a qualified
opinion or a disclaimer of opinion. A decision as to whether the auditors should
qualify or disclaim the opinion is dependent upon whether pervasive misstatements
are possible.
2.
(A,I)
Substantial doubt about an entity's ability to continue as a going concern leads to
either an unqualified opinion with an emphasis-of-matter paragraph, or a disclaimer.
Because the problem indicates a disclaimer will not be issued, only an unqualified
opinion with an emphasis-of-matter paragraph is appropriate.
3.
(A,M) A standard unmodified opinion is appropriate in circumstances in which a group
auditor takes responsibility for the work of a component auditor.
4.
(A,I)
When an auditor agrees with a change in accounting principles, a lack of consistency
results in an unmodified opinion with an emphasis-of-matter paragraph following the
opinion paragraph.
17-7
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
5.
(B,J)
Departures from generally accepted accounting principles result in either a qualified
opinion or an adverse opinion, based on the pervasiveness of misstatements. Given
that the situation suggests that the misstatement cannot be pervasive, a qualified
opinion is appropriate.
17–30 Task-Based Simulation
Report
Situation
Comment
1. A company has not followed generally accepted accounting
principles in the recording of its leases.
7
This is a departure from GAAP.
2. A company has not followed generally accepted accounting
principles in the recording of its leases. The amounts involved are
immaterial.
1
Because the amounts involved are immaterial,
no audit report modification is necessary.
3. A company valued its inventory at current replacement cost. While
the auditor believes that the inventory costs do approximate replacement
costs, these costs do not approximate any GAAP inventory valuation
method.
7
Although the auditor believes that the costs
approximate replacement costs, they depart from
GAAP.
4. A client changed its depreciation method for production equipment
from the straight-line method to the units-of-production method based
on hours of utilization. The auditor concurs with the change.
2
This situation involves a lack of consistency.
5. A client changed its depreciation method for production equipment
from the straight-line to a units-of-production method based on hours
of utilization. The auditor does not concur with the change.
7
Because the auditor does not concur with the
change, it is treated as a departure from GAAP.
6. A client changed the depreciable life of certain assets from 10
years to 12 years. The auditor concurs with the change.
1
A proper change in estimate does not require an
emphasis-of-matter paragraph.
7. A client changed the depreciable life of certain assets from 10
years to 12 years. The auditor does not concur with the change.
Confined to fixed assets and accumulated depreciation, the
misstatements involved are not considered pervasive.
3
Because the auditor does not concur with the
change in estimate, it is treated as a departure
from GAAP. A qualified report is appropriate
because the misstatements are not considered
pervasive.
8. A client changed from the method it uses to calculate
postemployment benefits from one acceptable method to another one.
The effect of the change is immaterial this year, but is expected to be
material in the future.
1
A change in accounting principles with an
immaterial effect (even if expected to become
material in the future) does not result in addition
of an emphasis-of-matter paragraph on
consistency.
9. A client changed the salvage value of certain assets from 5 percent
to 10 percent of original cost. The auditor concurs with the change.
1
This is a change in estimate that does not result in
addition of an emphasis-of-matter paragraph on
consistency.
10. A client uses the specific identification method of accounting for
valuable items in inventory, and LIFO for less valuable items. The
auditor concurs that this is a reasonable practice.
1
Consistency is a between periods concept; using
different inventory valuation methods such as
here is acceptable and does not result in an
emphasis-of-matter paragraph on consistency.
11. Due to recurring operating losses and working capital
deficiencies, an auditor has substantial doubt about an entity's ability
to continue as a going concern for a reasonable period of time. The
notes to the financial statements adequately disclose the situation.
6
This is a situation in which there is substantial
doubt about a client’s going concern.
12. Due to recurring operating losses and working capital
deficiencies, an auditor has substantial doubt about an entity's ability
to continue as a going concern for a reasonable period of time. The
notes to the financial statements do not adequately disclose the
substantial doubt situation, and the auditor believes the omission
fundamentally affects the users’ understanding of the financial
4
The lack of disclosure creates a departure from
GAAP. Because effects are pervasive
(fundamental to users’ understanding of the
financial statements is a characteristic of
pervasiveness), an adverse opinion is appropriate.
17-8
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
statements.
13. An auditor reporting on group financial statements decides to take
responsibility for the work of a component auditor who audited a 70
percent owned subsidiary and issued an unmodified opinion. The total
assets and revenues of the subsidiary are 5 percent and 8 percent,
respectively, of the total assets and revenues of the entity being audited.
1
Because the auditor takes responsibility for the
work of the component auditor, there is no
mention of the component auditor.
14. An auditor reporting on group financial statements decides not to
take responsibility for the work of a component auditor who audited a
70 percent owned subsidiary and issued an unqualified opinion. The
total assets and revenues of the subsidiary are 5 percent and 8 percent,
respectively, of the total assets and revenues of the entity being audited.
10
In this situation the auditor’s responsibility
section and the opinion sections have additional
wording added, but there is no emphasis-ofmatter paragraph in what remains a report with
an unmodified opinion.
15. An auditor was hired after year-end and was unable to observe the
counting of the year-end inventory. She is unable to apply other
procedures to determine whether ending inventory and related
information are properly stated.
8
This is a scope limitation.
16. An auditor was hired after year-end and was unable to observe the
counting of the year-end inventory. However, she was able to apply
other procedures and determined that ending inventory and related
information are properly stated.
1
Because the auditor has satisfied herself through
performing other procedures, a standard report is
appropriate.
17. An auditor discovered that a client made illegal political payoffs to a
candidate for president of the United States. The auditor was unable to
determine that amounts associated with the payoffs because of the
client's inadequate record-retention policies. The client has added a note
to the financial statements to describe the illegal payments and has stated
that the amounts of the payments are not determinable.
8
This is a scope limitation because of the
inadequate record retention policies and the
auditor’s inability to perform other procedures.
18. An auditor discovered that a client made illegal political payoffs to a
candidate for president of the United States. The auditor was unable to
determine that amounts associated with the payoffs because of the
client's inadequate record-retention policies, although there is no
likelihood that the financial statements are pervasively misstated, they
may be materially misstated. The client refuses to disclose the payoffs in
a note to the financial statements.
3
The lack of disclosure results in a departure from
GAAP. Because the effect is less than pervasive,
a qualified opinion is appropriate.
19. In auditing the long-term investments account of a new client, an
auditor finds that a large contingent liability exists that is material to the
consolidated company. It is probable that this contingent liability will
be resolved with a material loss in the future, but the amount is not
estimable. Although no adjusting entry has been made, the client has
provided a note to the financial statements that describes the matter in
detail.
1
Because the amount is not estimable, no
adjusting entry can be recorded. The auditor
might choose to emphasize this matter, but the
problem’s background rules out this treatment.
20. In auditing the long-term investments account of a new client, an
auditor finds that a large contingent liability exists that is material to the
consolidated company. It is probable that this contingent liability will
be resolved with a material loss in the future, and this amount is
reasonably estimable as $2,000,000. Although no adjusting entry has
been made, the client has provided a note to the financial statements that
describes the matter in detail and includes the $2,000,000 estimate in
that note.
7
Because the amount is estimable, an adjusting
entry should be recorded; since it was not, a
departure from GAAP exists.
21. A client is issuing two years of comparative financial statements.
The first year was audited by another auditor who is not being asked to
reissue her audit report. (Reply as to the successor auditor’s report.)
10
The successor auditor reports on year 2. But an
other-matter paragraph is added indicating (1)
the prior-period statements were audited by other
auditors, (2) the date and type of report issued
and, (3) if the report was other than standard, the
reasons therefore.
22. A client is issuing two years of comparative financial statements.
The first year was audited by another auditor who is being asked to
reissue her audit report. (Reply as to the successor auditor’s report.)
1
A standard report is issued on the second year.
The other auditor’s report on the first year is
reissued and included.
23. A client's financial statements follow GAAP, but the auditor wishes
2
This is an emphasis-of-matter situation.
17-9
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
to emphasize in his audit report a significant related party transaction
that is adequately described in the notes to the financial statements.
24. A client's financial statements follow GAAP except that they do not
include a note on a significant related party transaction.
7
This is a departure from GAAP. No information
is provided on whether the omission is
considered pervasive.
17–31 Task-Based Simulation
1.
Correct. The title should include the word “independent.”
2.
Correct. The report should include an addressee.
3.
Correct. There should be a section on management’s responsibility for the financial
statements.
4.
Incorrect. The report has the proper wording.
5.
Incorrect. Because Johnson & Barkley wish to assume responsibility for the work of Larkin &
Lake, no mention of Larkin & Lake should be made in the report.
6.
Incorrect. The paragraph is required.
7.
Correct. The emphasis-of-matter paragraph should follow the opinion paragraph.
8.
Incorrect. The opinion section should not mention consistency.
9.
Correct. The date should be the date on which sufficient appropriate audit evidence has been
gathered.
10.
Incorrect. The titles of the financial statements are not repeated in the opinion paragraph.
Problems
17–32 SOLUTION: Williams & Co., CPAs (Estimated time: 20 minutes)
The auditors' report contains the following deficiencies:
Introductory section
1.
The financial statements audited should individually be named.
Auditor’s Responsibility section
2.
3.
4.
What should be the second sentence is missing (“We conducted our audit in accordance with
auditing standards generally accepted in the United States of America.”)
An auditor obtains reasonable assurance about whether the financial statements are "free of
material misstatement," not "in conformity with generally accepted accounting principles"
(final sentence in first paragraph).
The one sentence final paragraph ("We believe that the audit provides a reasonable basis for
our opinion.") is omitted.
17-10
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
Emphasis-of-Matter section
5.
6.
The section should follow the opinion paragraph.
The auditors should not give an opinion concerning the entity's survival "beyond a reasonable
period of time."
Opinion section
7.
8.
9.
A qualified opinion is inappropriate (it should be unmodified).
The date of the financial statements audited is omitted.
There should be no reference to consistency.
17–33 SOLUTON: Lenses Co. (Estimated time: 20 minutes)
The auditors' report contains the following deficiencies:
1.
2.
The title should include the word “Independent”
The address ordinarily should not be management (it should be the board of directors, the
audit committee, or the shareholders, etc.)
Introductory paragraph
3.
It should begin with “We have audited….” rather than “We have examined….”.
4.
The final sentence concerning PCAOB requirements should not be included.
Scope paragraph
5.
The audit should be conducted in accordance with Public Company Accounting Oversight
Board standards rather than generally accepted auditing standards.
6.
The auditor obtains reasonable assurance, not positive assurance.
7.
The assurance relates to the financial statements being free of “material” misstatements not
“all” misstatements.
Opinion paragraph
8.
The term “present” should be “present fairly.”
9.
“Applied on a consistent basis” at the end of the paragraph is inappropriate and should be
deleted.
Internal control paragraph
10.
“We also have reviewed” at the beginning of the paragraph should be “We have audited.”
17–34 SOLUTION: Sturdy Corporation (Estimated time: 20 minutes)
a.
A separate basis for modification section (titled “Basis for Adverse Opinion”) should set forth
reasons for the expression of an adverse opinion and the principal effects of the subject matter
of the adverse opinion. The section should state the following, providing dollar amounts
where practicable:
 The company carries its building accounts at appraisal values and provides for
depreciation on the basis of such values.
 Buildings, accumulated depreciation, and equity (attributed to appraisals) are overstated.
 Net income is understated.
 Depreciation expense is overstated.
17-11
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
b.
The opinion paragraph should contain a reference to the separate paragraph and state the
financial statements do not present fairly the financial position, results of operations, and cash
flows. It should be worded as follows:
Adverse Opinion
In our opinion, because of the significance of the matter discussed in the Basis
for Adverse Opinion paragraph, the consolidated financial statements referred to
above do not express fairly the financial position of Sturdy Corporation as of
December 31, 19X3, and the results of its operations and its cash flows for the
year then ended.
17–35 SOLUTION: Excelsior Corporation (Estimated time: 25 minutes)
Independent Auditor’s Report
To the Board of Directors and Stockholders of Excelsior Corporation
We have audited the accompanying consolidated financial statements of Excelsior Corporation and its subsidiaries, which
comprise the consolidated balance sheet as of December 31, 20X1, and the related consolidated statements of income, changes
in stockholders’ equity and cash flows for the year then ended, and the related notes to the financial statements.
Management’s Responsibility for the Financial Statement
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance
with accounting principles generally accepted in the United States of America; this includes the design, implementation and
maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are
free from material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our
audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated
financial statement. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of
material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk
assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated
financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit
also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Basis for Qualified Opinion
The corporation declined to disclose that the agreement executed in conjunction with the issuance of the debentures of January 31,
20X1, for the purpose of financing expansion of plant facilities, restricts the payment of future cash dividends to earnings after
December 31, 20X1.
Qualified Opinion
In our opinion, except for the effects of omitting the information on the debentures discussed in the Basis for Qualified
Opinion Paragraph, the financial statements referred to above present fairly, in all material respects, the financial position of
Excelsior Corporation and its subsidiaries as of December 31, 20X1, and the results of their operations and their cash flows
for the year then ended in accordance with accounting principles generally accepted in the United States of America.
Emphasis-of-Matters
As discussed in note 11 to the financial statements, the corporation is the defendant in a lawsuit relating to (state type of litigation).
The ultimate outcome of the lawsuit cannot presently be determined, and no provision for any liability that may result has been
made in the financial statements. Our opinion is not modified with respect to this matter.
As discussed in note 12 to the financial statements, the corporation changed its method of accounting for long-term construction
contracts. Our opinion is not modified with respect to this matter.
17-12
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
Roscoe & Jones, Ltd
Silver, Bell, Arizona
February 10, 20X2
The only item of other information that is not part of the above report is Roscoe's failure to confirm
accounts receivable. When alternate procedures are performed and provide sufficient appropriate audit
evidence, the auditors need not refer to the omission of the normal procedures in the report.
This and the next problem are similar, although this problem is for a nonpublic company and includes
a departure from GAAP.
17–36 SOLUTION: Exchecker Corporation (Estimated time: 35 minutes)
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Exchecker Corporation
We have audited the accompanying consolidated balance sheets of Exchecker Corporation as of
December 31, 20X1 and 20X0, and the related consolidated statement of income, stockholders’ equity, and cash
flows for each of the three years in the period ended December 31, 20X1. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
consolidated financial position of Exchecker Corporation at December 31, 20X1 and 20X0, and the consolidated
results of its operations and its cash flows for each of the three years in the period ended December 31, 20X1, in
conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), Exchecker Corporation’s internal control over financial reporting as of December 31, 20X1, based
on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated February 10, 20X2 expressed an unqualified
opinion thereon.
As discussed in note 11 to the financial statements, the corporation is the defendant in a lawsuit relating to (state
type of litigation). The ultimate outcome of the lawsuit cannot presently be determined, and no provision for any
liability that may result has been made in the financial statements.
As discussed in note 12 to the financial statements, the corporation changed its method of accounting for longterm construction contracts.
Rotter & Co, Ltd
Silver Bell, Arizona
February 10, 20X2
The only item of other information that is not part of the above report is Roscoe's failure to confirm
accounts receivable. When alternate procedures are performed and provide sufficient appropriate audit
evidence, the auditors need not refer to the omission of the normal procedures in the report.
17-13
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
This and the preceding problem are similar, although this is for a public company. Also, we omitted
the departure from GAAP since the SEC will ordinarily not allow qualified reports.
In-Class Team Case
17–37 Reporting Scenarios (Estimated time: 50 minutes)
Circumstance
1
GAAP
Type of Opinion
Report Alteration
Q
BFM
A
BFM
2
EMPH
U
EOM
3
SCOPE
Q
BFM
D
BFM
U
EOM
D
BFM
4
GC
5
GROUP
U
OTHER
6
GROUP
U
NO
7
CON or NONE
U
NO
8
CON
U
NO
9
EMPH
U
EOM
10
COMP
U
OM
Note on placement of paragraphs:
EOM—After opinion section.
OM—After opinion section (also after any EOM).
BFM—Prior to opinion paragraph.
17-14
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
17–38
Situation
A company in its first year of existence values its inventory at
current replacement cost. Although you believe that the
inventory costs do approximate replacement costs, these costs
do not approximate any GAAP inventory valuation method. The
difference involved is material, but not pervasively material to
the financial statements.
2. Due to recurring operating losses and working capital
deficiencies, you have substantial doubt about an entity’s ability
to continue as a going concern for a reasonable period of time.
The notes to the financial statements adequately disclose the
substantial doubt situation.
3. You have discovered that a client made illegal payoffs to a
candidate for president of the United States. You are unable to
determine the amounts associated with the payoffs because of
the client’s inadequate record retention policies. The client has
added a note to the financial statements to describe this all, and
has stated that the amounts of the payments are not
determinable.
4. In auditing the long-term investments account of a new client,
you find that a $2,000,000 contingent liability exists that is
material to the consolidated company. It is probable this
contingent liability will be resolved with a material loss in the
future. Although no adjusting entry has been made, the client
has provided a note to the financial statements that describes the
matter in detail and includes the $2 million estimate.
5. A client is issuing 2 years of comparative financial statements.
The first year was audited by another auditor who is not being
asked to reissue her audit report.
6. An entity changes its depreciation method for production
equipment from the straight-line to the units-of-production
method based on hours of utilization. You concur with the
change.
7. A client has changed the method it uses to calculate
postemployment benefits from one acceptable method to another
one. The effect of the change is immaterial this year, but
expected to be material in the future.
8. A component auditor has audited a subsidiary of your client as a
part of a group audit. You have decided to rely upon the
component auditor’s work.
9. A client omits a note disclosure related to significant accounting
policies that the auditor believes to be fundamental to users’
understanding of the financial statements.
10. A client does not count its year-end inventory. The auditors are
unable to obtain sufficient appropriate audit evidence related to
inventory and they consider inventory as representing an
extremely substantial proportion of the financial statements.
Opinion
Opinion
1.
Q
U
D
Q
D
Q
A
U
U
S
S
A
D
17-15
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Chapter 17 - Auditors' Reports
Research and Discussion Case
17–39 Metropolitan Power Supply (Estimated time: 55 minutes)
a.
Arguments for auditors insisting that some portion of construction costs be expensed:
 The concept that an asset should not be carried at a value greater than its "service
potential" is FASB ASC 360-10. This statement requires that the carrying amount of an
asset be reduced whenever the sum of the expected future cash flows is less than the
carrying amount.
 It appears that Eagle Mountain ultimately will cost far more than MPS can expect to
recover through operations. Therefore, some of the total cost should be regarded as a loss,
not as a productive asset. The asset should be written down to its fair value. The fair
value is probably best measured as the present value of the expected future cash flows
from the plant. Granted, the computation of the loss is somewhat subjective, but it must
be done to fairly present the asset.
Argument against insisting that some construction costs be expensed:

As MPS’s auditors, we do not know what the future cash flows from operations will be.
Presumably, the “recoverable costs” are whatever the state utilities commission ultimately
allows MPS to pass on to its ratepayers. Until this determination is made, or until MPS
abandons the project, any guesses as to the recoverable cost would be sheer speculation.
Our opinion on part a: We believe that the carrying value of the plant should be reduced to its
estimated fair value measured as the discounted expected future cash flows from the plant in
accordance with FASB ASC 360-10-35. Management of MPS should be able to reasonably
estimate the amount of the cost that the utility commission will allow the company to recover
based on their experience in the industry.
b.
It appears that there is considerable risk that continuing with the Eagle Mountain project may
ultimately cause MPS to become insolvent. The question, therefore, is whether this risk is
sufficient for the auditors to modify their report as to MPS's ability to remain a going concern.
Although the case does not make it altogether clear when the company would be likely to
become insolvent, there is no indication that it will within a one-year period as indicated in
AICPA AU 570 (PCAOB 341) relating to going concern questions. Thus, the facts do not
suggest that auditors should issue a going concern modification merely because they anticipate
problems years down the road.
In the opinion of the authors, the client should receive the benefit of the doubt. An opinion
should not be modified with respect to a going-concern question unless there is substantial
doubt that the client will become insolvent within one year from the date of the balance sheet.
To speculate over longer periods of time simply involves too much conjecture to be consistent
with the attest function.
Although we would not modify our opinion as to MPS's ability to remain a going concern, we
would consider including an emphasis-of-matter paragraph describing the uncertainty
surrounding the ultimate realization of the capitalized construction costs. Therefore, we would
consider including an emphasis-of-matter paragraph discussing the company's ability to
finance the completion of the Eagle Mountain facility and to recover the capitalized
construction costs.
17-16
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.
This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.